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Over the last few years, the value of the U.S. dollar has fallen by more than 15 percent–and by more than 50 percent against Europe’s currency, the euro. Financial commentators expect the decline of the dollar to continue–with the nightmare scenario being a further big drop causing an international financial crisis.
The value of a country’s currency rises and falls because of a combination of factors, including international investment flows and government policies. One of the most important is a country’s balance of trade–the difference between exports and imports.
The annual U.S. trade deficit has increased more than eightfold from a two-decade low of $77 billion in 1991 to almost $650 billion by the end of 2004. That’s about 6 percent of U.S. Gross Domestic Product (GDP)–the measure of the overall size of the U.S. economy. In a poor country, when the trade deficit climbs above 5 percent of GDP, the International Monetary Fund usually steps in to insist on a “structural adjustment” program.
Meanwhile, the U.S. government has gone from a budget surplus at the end of the 1990s to a record-setting deficit of $412 billion in 2004, all in less than a decade. The most important causes have been the Bush administration’s trillion-dollar tax cut giveaways to the super-rich and massively increased military spending thanks to the “war on terror.” And there’s more red ink to come with the Bush team’s plans to privatize Social Security and push through even more tax cuts.
“If this country were named Argentina or Indonesia, it would be a clear candidate for financial crisis any day now,” economist and New York Times columnist Paul Krugman said in a recent radio commentary.
The size of the U.S. trade deficit really took off in the late 1990s, when the U.S. government pumped large amounts of money into the economy to stop America from suffering the financial crisis that struck countries throughout East Asia beginning in 1997. The strategy did stop the U.S. from coming down with the “Asian flu.” But one major consequence was a huge increase in imports of goods and services into the U.S., as the American market soaked up other countries’ exports.
The trade gap is so big now that U.S. exports of goods and services would have to grow by 50 percent to reach the level of U.S. imports.
A deficit this big can’t be paid for domestically. So the U.S. has been funding its balance of payments deficits by borrowing from the rest of the world–to the tune of $1.8 billion a day.
Add in the skyrocketing government deficit–which is competing with the trade deficit in trying to attract foreign capital to finance it–and it’s obvious that the U.S. has become far and away the world’s biggest debtor.
Who are the lenders? This year, China, Japan and other East Asian countries are expected to finance half the annual U.S. trade deficit. As Financial Times columnist John Plender wrote, the world’s “lone superpower now depends on China as the swing financier for its gigantic current account deficit.”
That’s why the dollar crisis finally attracted mainstream media attention last month when rumors spread that central banks in China, India and Russia were starting to divert their holdings of foreign currencies out of dollars because of the decline in their value.
The Bush White House claims that it is committed to keeping the dollar strong, but this is hot air. Actually, the administration has actively encouraged a controlled decline in the value of the dollar.
One goal is to lower the U.S. trade deficit. A weaker dollar benefits U.S. manufacturers because U.S. exports are cheaper to buy in other countries, and other countries’ exports become more expensive in the U.S. Yet the trade deficit has continued climbing despite the dollar’s decline over the past year.
U.S. policymakers also understand that the accumulated debt from the twin deficits becomes cheaper to pay off. “In essence, what is happening is that the American government is defaulting on a part of its debt,” Joel Geier, associate editor of the International Socialist Review, said in a recent interview. “They will pay back the debt at its face value, but in a devalued currency. It’s not declaring bankruptcy, but the world’s biggest debtor is telling its creditors: ‘We’ll pay you 80 cents on the dollar, or 60 cents on the dollar.’ Try that with your credit card company.”
This is playing with fire–because the more the dollar drops in value, the less incentive other countries will have to continue financing the U.S. balance of payments deficit. “The break can come either from the Reserve Bank of China deciding it has enough dollars, thank you, or from private investors saying ‘I’m going to take a speculative bet on a dollar plunge,’ which then ends up being a self-fulfilling prophecy,” Krugman said.
Even if the White House avoids this nightmare scenario, working people will pay a price in declining living standards. The administration’s unstated policy of letting the dollar slide means not only that imported products are more expensive to buy, but that prices will rise across the board.
This hasn’t shown up in the government’s official inflation statistics yet. But these figures are increasingly misleading because they exclude so many essential products–like, for example, gas, which has jumped in price over the last several years–because they are supposedly “too volatile” to measure properly.
Also, the high level of consumer spending in the U.S. was kept going through the recession by a boom in mortgage refinancing because of low interest rates. This provided homeowners with extra cash to spend even as real wages declined. But the decline in the dollar’s value is already pushing up interest rates, slowing the refinancing frenzy and threatening a more severe crisis if the bubble in real estate values caused by the mortgage boom is punctured.
As Geier puts it, “The press may present [the Bush administration’s dollar policy] as a brilliant stroke by the political representatives of the U.S. capitalist class, but it is not a sign of strength…[T]he U.S. remains the dominant power, and it is on this basis that it assumes that the rest of the world will bail it out. The U.S. ruling class may get this if the dollar collapses, because Europe, Japan and Asia can’t afford for that to happen. But that won’t enhance U.S. credibility.”
Since the election, the mainstream media–as well as many progressives–have acted as if the Bush administration is all-powerful. But the dollar crisis with all its looming consequences shows the fault lines and weaknesses right below the surface.
Read Joel Geier’s interview “Dimensions of the U.S. Dollar Crisis” in the International Socialist Review.